The Bank of England warned that some 4 million households will face a sharp increase in mortgage costs, with the average borrower paying almost £3,000 a year more.
(Bloomberg) — The Bank of England warned that some 4 million households will face a sharp increase in mortgage costs, with the average borrower paying almost £3,000 a year more.
Governor Andrew Bailey said Wednesday that the surge in mortgage rates will have an “impact clearly” on finances as the central bank’s Financial Stability Report predicted that 1 million households face a £500-plus hike in monthly repayments.
“There will still be consequences from increased interest rates I’m afraid because from a monetary policy perspective, that’s why we have to do it,” Bailey said in a press conference in London following the report. However, he said that households and firms are less likely to slash spending and default on debts than previous periods of high rates.
The assessment in the report underscores the strain from the quickest series of rate rises in three decades with trouble among buy-to-let landlords highlighted as a threat to house prices. The action is meant to slow the economy and rein in inflation, but will bring real pain for consumers already coping with the tightest squeeze in living standards in generations.
The issue is becoming a key battleground between the UK’s two main political parties ahead the next election, which is widely expected in 2024. Prime Minister Rishi Sunak’s government has been looking for ways to ensure that savers benefit from higher interest rates and give borrowers flexibility in restructuring their finances.
The BOE said that a typical household rolling off a fixed-rate deal in the second half of 2023 face a £220 per month increase in their mortgage costs based on current rates — equivalent to £2,640 a year.
By the end of 2026, about 1 million households will have seen their payment go up by more than £500 a month. This assumes they refinance at the same maturity, but about 15% of mortgagees have extended the length of their loans. Some are repaying using their savings, which reduces the quantity of loans they are refinancing.
“It will take time for the full impact of higher interest rates to come through both in the UK and in other advanced economies,” Bailey said. “Elements of the global financial system do remain vulnerable to interest rates.”
The warning comes after Moneyfacts revealed that the average rate for fixed two-year home loans rose to 6.66%, the highest since August 2008. The pain for homeowners could get even worse with markets pricing in a peak Bank rate of almost 6.5% to tackle sticky inflation.
However, the BOE’s report and comments suggest that financial stability concerns will not stand in the way of further interest rate rises. Bailey said that for now both borrowers and lenders are in better condition to shoulder difficulty than they were in previous rate cycles.
“Compared to previous periods of high interest rates, households and businesses are less likely to cut back on spending and default on loans,” Bailey said. “More broadly, the UK economy and financial system have so far been resilient to interest rate risk.”
The amount all UK households will have to pay out on mortgage costs will climb to 8% of their post-tax income by 2026, up from 6.2%. However, it is still below the peak seen in the global financial crisis and the early 1990s recession.
The BOE said the mortgage interest burden, adjusted for living costs, is likely to increase this year. The BOE said about 650,000 households, or 2.3% the total, will have feel a significant strain. That’s short of the levels that they hit in 2007, which triggered a sharp drop in house prices.
The BOE said that an exodus of buy-to-let landlords facing higher mortgage costs threatens to hit house prices as many consider selling their properties. Some landlords are more vulnerable after taking out interest-only mortgage deals and many are hiking rents to cover their higher costs.
“Falling profitability could, in principle, cause landlords to sell their property investments and exit the buy-to-let market,” the Financial Stability Report said. “If this were to happen in large enough volumes, it could put downward pressure on house prices.”
The BOE said landlords — who are set to face a £275 per month hike in monthly repayments on average by the end of 2025 — will likely put up rents to offset the blow. UK private rents already rose 5% in the year to May, the largest increase since records began in 2016.
Cunliffe said a move out of the sector by landlords is part of a shift after the buy-to-let sector was fueled by low borrowing costs that are now coming to an end.
“Now we’re in a period of higher interest rates where there are other returns in other sorts of investments and you would expect that there will be some rebalancing as we move,” he said.
While mortgage arrears remain low by historical standards, the BOE’s Financial Policy Committee said they are increasing and that it will “take time for the full impact of higher interest rates to come through.”
It said that mortgage defaults will be limited by a resilient banking sector and stricter regulatory standards. The impact of the higher mortgage costs has also been delayed by a huge shift in the UK from variable rate mortgages to fixed rate deals typically lasting two or five years.
Despite the surge in the cost of a two-year mortgage, Andrew Asaam, mortgage director for Lloyds Banking Group, said “the split between two- and five-year fixed has moved more towards two-years,” suggesting borrowers are banking on interest rates eventually coming down.
Steven Major, HSBC’s global head of fixed income research, told Bloomberg TV that the BOE has a “thankless task” as it tries to bring down inflation while contending with the lagged impact of mortgage rates.
“Everyone recognizes there’s a lag effect and this is one of them — we know the numbers of how many people have fixed rate mortgages, but we don’t know how exactly they will behave when they get the shock,” he said.
Read more:
- Largest UK Lenders Pass Latest Bank of England Stress Tests
–With assistance from Philip Aldrick, Damian Shepherd and Lucy White.
(Updates 13th paragraph with BOE’s assessment of mortgage pain.)
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